Music Mart, Inc.

On Jan.1 John Smith starts an incorporated CD and tape store called Music Mart, Inc. He does this by
depositing $25,000 of his own funds in a bank account that he has opened in the name of the business
entity and taking $25,000 of stock certificates in return. He is the sole owner of the corporation. The
balance sheet of Music Mart, Inc., will then be as follows:

MUSIC MART

Balance Sheet

As of January 1

Assets Liabilities and Owner’s Equity

Cash $25,000 Paid-in capital $25,000

On Jan.2 Music Mart borrows $12,500 from a bank; the loan is evidenced by a legal document called a
note. This transaction increases the asset, cash, and the business incurs a liability to the bank called notes
payable. The balance sheet after this transaction will appear thus:

MUSIC MART

Balance Sheet

As of January 2

Assets Liabilities and Owner’s Equity

Cash $37,500 Notes payable $12,500
Paid-in capital 25,000
Total $37,500 Total $37,500
On Jan.3, The business buys (merchandise it intends to sell) in the amount of $5,000, paying cash. This
transaction decreases cash and increases another asset, inventory. The balance sheet will now be as
follows:

MUSIC MART

Balance Sheet

As of January 3

Assets Liabilities and Owner’s Equity

Cash $32,500 Notes payable $12,500
Inventory 5,000 Paid-in capital 25,000
Total $37,500 Total $37,500

On Jan.4, for $750 cash, the store sells merchandise that costs $500. The effect of this transaction is to
decrease inventory by $500, increase cash by $750, and increase owner’s equity by the difference, or
$250. The $250 is the profit on this sale. To distinguish it from the paid-up capital portion of owner’s
equity, it is recorded as retained earnings. The balance sheet will then look like this:

MUSIC MART

Balance Sheet

As of January 4

Assets Liabilities and Owner’s Equity

Cash $33,250 Notes payable $12,500
Inventory 4,500 Paid-in capital 25,000
Retained earnings 250
Total $37,750 Total $37,750
On a sheet of paper, set up in pencil the balance sheet of Music Mart, Inc., as it appears after the last
sheet of Music Mart, Inc., as it appears after the last transaction described in the text (January 4), leaving
considerable space between each item. Record the effect, if any, of the following events on the balance
sheet, either by revising existing figures (cross out, rather than erase) or by adding new items as necessary.
At least one of these events does not affect the balance sheet. The basic equation, Assets = Liabilities +
Owners’ equity, must be preserved at all times. Errors will be minimized if you make a separate list of the
balance sheet items affected by each transaction and the (+ or - ) by which each is to be changed.

After you have recorded these events, prepare a balance sheet in proper form. Assume that all these
transactions occurred in January and that there were no other transactions in January.

1. The store purchased and received merchandise for inventory for $5,000, agreeing to pay within
30 days.

Assets Liabilities and Owner’s Equity

Cash $33,250 Notes payable $12,500
Inventory 9,500 Paid-in capital 25,000
Retained earnings 250
Trade Creditor 5000
Total $42,750 Total $42,750

2. Merchandise costing $1,500 was sold for $2,300, which was received in cash.

Assets Liabilities and Owner’s Equity

Cash $35,550 Notes payable $12,500
Inventory 8000 Paid-in capital 25,000
Retained earnings 1050
Trade Creditor 5000
Total $43,550 Total $43,550

3. Merchandise costing $1,700 was sold for $2,620, the customers agreeing to pay $2,620 within 30
days.

Assets Liabilities and Owner’s Equity

Cash $35,550 Notes payable $12,500
Inventory 6300 Paid-in capital 25,000
Receivable 2620 Retained earnings 1970
Trade Creditor 5000
Total $44470 Total $44470
4.
 5. The store purchased a three-year fire insurance policy for $1,224, paying cash.

Assets Liabilities and Owner’s Equity

Cash $34326 Notes payable $12,500
Inventory 6300 Paid-in capital 25,000
Receivable 2620 Retained earnings 1970
Pre-Paid Insurance $1224 Trade Creditor 5000
Total $44470 Total $44470

6. The store purchased two lots of land of equal size for a total of $24,000. It paid $6,000 in cash and
gave a 10-year mortgage for $18,000.

Assets Liabilities and Owner’s Equity

Cash $28326 Notes payable $12,500
Land $24000 Mortgage loan $18000
Inventory 6300 Paid-in capital 25,000

Receivable 2620 Retained earnings 1970

Pre-Paid Insurance $1224 Trade Creditor 5000
Total $62470 Total $62470

7. The store sold one of the two lots of land for $12,000. It received $3,000 cash, and in addition,
the buyer assumed $9,000 of the mortgage; that is, Music Mart, Inc., became no longer
responsible for this half.

Assets Liabilities and Owner’s Equity

Cash $31326 Notes payable $12,500
Land $12000 Mortgage loan $9000
Inventory 6300 Paid-in capital 25,000

Receivable 2620 Retained earnings 1970

Pre-Paid Insurance $1224 Trade Creditor 5000
Total $53470 Total $53470
 8. Smith received a bonafide offer of $33,000 for the business; although his equity was then only
$26,970, he rejected the offer. It was evident that the store had already acquired goodwill of
$6,030.

Assets Liabilities and Owner’s Equity

Cash $31326 Notes payable $12,500
Land $12000 Mortgage loan $9000
Inventory 6300 Paid-in capital 25,000

Receivable 2620 Retained earnings 1970

Pre-Paid Insurance $1224 Trade Creditor 5000
Total $53470 Total $53470

9. Smith withdrew $1,000 cash from the store’s bank account for his personal use.

Assets Liabilities and Owner’s Equity

Cash $30326 Notes payable $12,500
Land $12000 Mortgage loan $9000
Inventory 6300 Paid-in capital 24,000

Receivable 2620 Retained earnings 1970

Pre-Paid Insurance $1224 Trade Creditor 5000
Total $52470 Total $52470

10. Smith took merchandise costing $750 from the store’s inventory for his personal use.

Assets Liabilities and Owner’s Equity

Cash $30326 Notes payable $12,500
Land $12000 Mortgage loan $9000
Inventory 5550 Paid-in capital 23250

Receivable 2620 Retained earnings 1970

Pre-Paid Insurance $1224 Trade Creditor 5000
Total $51720 Total $51720

11. Smith learned that the individual who purchased the land (No.6 above) subsequently sold it for
$14,000. The lot still owned by Music Mart, Inc., was identical in value with this other plot.

Assets Liabilities and Owner’s Equity

Cash $30326 Notes payable $12,500
Land $12000 Mortgage loan $9000
Inventory 5550 Paid-in capital 23250

Receivable 2620 Retained earnings 1970

Pre-Paid Insurance $1224 Trade Creditor 5000
Total $51720 Total $51720

12. The store paid off $6,000 of its note payable (disregard interest).

Assets Liabilities and Owner’s Equity

Cash $24326 Notes payable $6,500
Land $12000 Mortgage loan $9000
Inventory 5550 Paid-in capital 23250

Receivable 2620 Retained earnings 1970

Pre-Paid Insurance $1224 Trade Creditor 5000
Total $45720 Total $45720

13. Smith sold one-third of the stock he owned in Music Mart, Inc., for $11,000 cash.

Assets Liabilities and Owner’s Equity

Cash $24326 Notes payable $6,500
Land $12000 Mortgage loan $9000
Inventory 5550 Paid-in capital 23250

Receivable 2620 Retained earnings 1970

Pre-Paid Insurance $1224 Trade Creditor 5000
Total $45720 Total $45720

14. Merchandise costing $850 was sold for $1,310, which was received in cash.

Assets Liabilities and Owner’s Equity

Cash $25636 Notes payable $6,500
Land $12000 Mortgage loan $9000
Inventory 4700 Paid-in capital 23250

Receivable 2620 Retained earnings 2430

Pre-Paid Insurance $1224 Trade Creditor 5000
Total $46180 Total $46180